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Has Netflix Become the Perfect Stock?

Finding companies that have all the right stuff can produce winners.

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Netflix(Nasdaq: NFLX) fits the bill.

The quest for perfectionStocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.

Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.

Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.

Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.

Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.

Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Netflix.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

26.2%

Pass

1-year revenue growth > 12%

41.2%

Pass

Margins

Gross margin > 35%

37.4%

Pass

Net margin > 15%

8%

Fail

Balance sheet

Debt to equity < 50%

70.4%

Fail

Current ratio > 1.3

1.33

Pass

Opportunities

Return on equity > 15%

83.6%

Pass

Valuation

Normalized P/E < 20

27.20

Fail

Dividends

Current yield > 2%

0%

Fail

5-year dividend growth > 10%

0%

Fail

Total score

5 out of 10

Source: S&P Capital IQ. Total score = number of passes.

When we looked at Netflix last year, it had the same score of 5. But thanks to the recent controversy, the company has seen its normalized earnings multiple shrink by more than half, even while returns on equity and revenue growth have risen dramatically.

Until recent months, Netflix seemed to be firing on all cylinders. The company was seeing increased interest in its streaming service, and with plans to expand to 43 more countries throughout Latin America, global domination seemed like a distinct possibility for Netflix.

But then all hell broke loose. The company announced a pricing plan that imposed a 60% increase on customers who wanted to keep both DVD-by-mail and streaming service. Then, Netflix said that it would break up the service into two parts, forcing customers to maintain two distinct accounts to manage streaming and DVDs separately. The company quickly backed away from the Qwikster fiasco, but fears remain that the damage has been done.

Now, many believe that competitors have the upper hand. On one hand, Redbox operator Coinstar(Nasdaq: CSTR) and Blockbuster bankruptcy-buyer DISH Network(Nasdaq: DISH) can reap the benefits of Netflix's apparent disdain for the DVD side of its business. At the same time, streaming competitors like Amazon.com(Nasdaq: AMZN), which entered the market with a streaming add-on to its Amazon Prime service, could see greater traction just from the general ill will that Netflix's moves generated.

More importantly in the long run, though, are the challenges that Netflix and its peers face in getting streamable content. Although Liberty Starz(Nasdaq: LSTZA) dropped out of negotiations to renew its deal with Netflix, the streamer made a deal with DreamWorks Animation(Nasdaq: DWA) that gives Netflix rights to films and TV specials.

The future for Netflix depends on whether customers will actually abandon the service or are just blowing smoke with their complaints. If customers realize that alternatives are still more expensive, they'll probably stick around -- and that should help restore Netflix to at least some of its former glory.

Keep searchingNo stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Click hereto add Netflix to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our "13 Steps to Investing Foolishly."

Fool contributorDan Caplingerdoesn't own shares of the companies mentioned.Motley Fool newsletter serviceshave recommended buying shares of Netflix, DreamWorks Animation, and Amazon.com. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has adisclosure policy.

Author

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
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